Question

In: Finance

Tara's textiles currently has credit sales of 360 million per year and a collection period of...

Tara's textiles currently has credit sales of 360 million per year and a collection period of 60 days. Assume that the price of Tara's products is $60 per unit and that the variable costs are $55 per unit. The firm is considering an accounts receivable charge that will result in a 20% increase in sales and a 20% increase in the average collection period. No changes in bad debt is expected. The firm's equal risk opportunity cost on its investment in accounts receivable is 14%.

A. calculate the additional profit contribuations from sales that the firm will realize if it makes the proposed change

b. What marginal investment in accounts receivable will result?

c. calculate the cost of marginal investment in accounts receivable

d. should the firm implement the proposed change? What other information would be helpful in your analysis?

Expert Solution

A.

Current volume of sales = $ 360,000,000 / $ 60 = 6,000,000 units

Increase in sales = 6,000,000 x 20 % = 1,200,000 units

Additional profit contribution = 1,200,000 x $ ( 60 - 55 ) = $ 6,000,000.

B.

Accounts receivable turnover, current plan = 360 days / 60 days = 6 times

Accounts receivable turnover, proposed plan = 360 days / ( 60 days x 1.2) = 5 times

Average investment under proposed plan = ( 7,200,000 units x $ 55 ) / 5 = $ 79,200,000

Average investment under current plan = ( 6,000,000 units x $ 55 ) / 6 = $ 55,000,000

Marginal investment in accounts receivable = $ 79,200,000 - $ 55,000,000 = $ 24,200,000.

C. Cost of marginal investment in accounts receivable = $ 24,200,000 x 14 % = $ 3,388,000.

D. Yes.

The additional profit contribution of $ 6,000,000 exceeds cost of marginal investment in accounts receivable of $ 3,388,000. Therefore, the firm should implement the proposed change.

Information about bad debt expense, additional collection costs, additional administrative charges that might be incurred etc would be useful in making the analysis.

jeff jeffy answered 7 months ago

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